Yuan Hui & An Shouzhi 

Preface

In recent years, China has seen numerous cases of oil spillage from vessels. In these cases, the aggrieved parties to the oil pollution usually claimed directly against the insurer – the protection and indemnity club (P&I club) responsible for the liabilities of the owner of the ship that caused the oil pollution damage – as per Article 97 of the Special Maritime Procedure Law of P.R.C., requiring the P&I club to bear joint and several liability for the oil pollution damage. This triggers a series of legal issues relating to direct action against P&I clubs, including whether a direct action can be brought against P&I club, the validity of a “pay first” clause, other defenses of P&I clubs, limitations of liability, and so forth. In this article, the authors will analyze these issues, and present some viewpoints.

I. 　Whether a direct action can be brought against P&I Club

1. 　Overview

Direct action refers to the right of a third party who has a liability claim against an assured to proceed directly by suit against the insurer, usually because the assured has been declared bankrupt or has become insolvent. The third party may claim against the insurer even though he has no direct contractual relationship with the insurer.

Some maritime international conventions such as the Convention on the Liability of Operators of Nuclear Ships 1962 allow for direct action against the insurer, in that the aggrieved party may bring an action either against the operator of the vessel, or against the insurer of nuclear damage or any person which has provided financial security to the operator (except the licensing State).  On the other hand, the Convention also provides that the right to bring a direct action must be permitted under the “applicable national law”. Otherwise, the aggrieved party may not bring such a direct action.

The International Convention on Civil Liability for Oil Pollution Damage 1969 (hereinafter referred as “1969 CLC”) provides that “any claim for compensation for pollution damage may be brought directly against the insurer or other parties providing financial security for the owner’s liability for pollution damage”. Meanwhile, it also provides that the owner of a ship registered in a Contracting State and carrying more than 2,000 tons of oil in bulk as cargo should be required to have in place insurance or other financial security in order to cover its liability for pollution damage under this Convention.  The International Convention on Civil Liability for Bunker Oil Pollution Damage 2001 makes similar provisions for direct action.

The domestic laws of some nations allow a third party to bring a direct action against the insurer under the condition that the assured has bankrupted or closed down including the UK Third Parties (Rights Against Insurers) Act 1930.  However, the House of Lords has confirmed that this Act does not allow a third party to bring a direct action against a P&I club. 

In the United States, marine insurance is in principle governed by courts at federal level. But federal maritime law provides neither for the right to directly claim against the insurer, nor for special restrictions prohibiting the commencement of such litigation.  Depending on the legal provisions of each state and the terms agreed in the marine contract, a third party may or may not be entitled to bring a direct action against a marine insurer or P&I club.  For example The Direct Action Act of Louisiana allows a third party to bring a direct action against the insurer with a special exception for “marine insurance”. In 1993 however, the Louisiana Court of Appeals made a judgment allowing a third party to bring a direct action against a P&I club.  In Michigan and Texas on the other hand, direct action may not be brought against the insurer based on an indemnity insurance policy.

In Canadian provinces where common law prevails, a third party may bring a direct action against the insurer for liability of an assured that has been bankrupted or liquidated, only after the liability of the assured has been established by judgment. In provinces where the Civil Code of Quebec 1991 is applicable, a third party can bring a direct action against the liability insurer and marine insurer no matter whether the assured is insolvent or not. 

To sum up, relevant international conventions and national laws entitle a third party to bring a direct action against the insurer, but most laws set conditions to various degrees under which direct action applies. For example the assured should have been insolvent, or the third party should first establish the liability of the assured by judgment. The reason for such provisions is that direct action represents a break with the principle of the “privity of contract”. On the one hand the law entitles the third party to bring a direct action against the insurer for the purpose of protecting the general public or specific third parties, while on the other hand the law provides for strict conditions for direct action in order to prudently maintain the principle of the “privity of contract”.

2. 　Chinese legal provisions on direct action for oil pollution damage

China’s Maritime Code does not expressly give third parties the right to bring a direct action against the mariner insurer of liability insurance. The Insurance Law of P.R.C. provides that the liability insurer may directly indemnify a third party in accordance with the provisions of law or the terms of an insurance contract, but only empowers the insurer to choose to directly indemnify the third party or not; the liability insurer “may”, instead of “shall”, directly indemnify the third party.   Therefore, this law does not grant a third party the right to bring a direct action against the liability insurer.

On 5 January 2000 China acceded to the 1992 CLC. According to provisions of this Convention, any claim for compensation for pollution damage may be brought directly against the insurer or another person providing financial security for the owner’s liability for pollution damage. In the meantime, through the Convention China requires the owner of a ship navigating in international routes and carrying more than 2,000 tons of bulk cargo to maintain insurance or other financial security (e.g. a Letter of Guarantee or Letter of Credit).

Article 97 of the Special Maritime Procedure Law, effective on 1 July 2001, provides that an aggrieved party may claim for oil pollution damage caused by a ship either against the owner of the ship causing the oil pollution damage, or directly against the insurer who is answerable for the liabilities of the owner of the ship causing oil pollution damage, or against the party that provides financial security therefor. This Article procedurally entitles the aggrieved party of oil pollution to bring a direct action against the liability insurer for oil pollution damage.

3. 　Whether a P&I club is a liability insurer of oil pollution

P&I clubs have existed for more than 150 years. Since the first P&I club was formed in the United Kingdom in 1855, their organizational forms and legal natures have been in constant change. In its early stage of development, the P&I club did not formally register as a company or other economic organization that independently bore responsibility to any outsiders. The relation of the insurance contract only existed among members of the club, with one member “individually” bearing proportionate responsibilities to other members, club members being either the assured or the insurer, the state of which truly embodies the character of a “mutual insurance”. After the UK’s Company Law of 1962 provided that an organization with more than twenty persons has to register if it collected fees for providing services, and a court judged that an insurance policy issued by this kind of association was null and void because the name of the insurer was not noted in the insurance policy,  many P&I clubs quickly restructured into a company.  On the other hand, the China Shipowners Mutual Assurance Association (China P&I Club) founded in Beijing in 1984 is currently still a social organization.

Article 10 of the Insurance Law provides that, “the insurer means the insurance company, which enters into an insurance contract with an applicant and is obligated to make indemnity or pay insurance benefit”. Also according to Articles 70 and 73, an insurance company shall take the form of stock company with limited liability or a wholly State-owned company and has a minimum registered capital of RMB200,000,000 yuan. Within this context, it is difficult to define the P&I club, and in particular the China P&I Club, as a liability insurer of oil pollution damage. Still, it is worth pointing out that under Article 7 of China’s Guaranty Law,  a P&I club may act as a surety and the credit guarantee (Letter of Guarantee) it provides to its members is valid.

In practice, however, the P&I clubs have already become liability insurers of oil pollution. After China acceded to the 1969 CLC on 29 April 1980, the China Harbor Superintendency Bureau (now the MSA) circulated a notice that an “insurance or other financial security certificate for civil liability against oil pollution damage” may be issued to vessels holding an “insurance certificate of oil pollution” of the China P&I Club, and “all protection and indemnity risks including oil pollution risks” may be filled in the column of “type of security” of this certificate.  In judicial practice, the courts in China usually deem the P&I club as the liability insurer of oil pollution.

4. 　Direct action and compulsory insurance/financial security of oil pollution

Oil pollution by vessels is usually a kind of tort resulting from a sudden environmental accident, giving rise to a vast polluted territory, a great number of aggrieved parties and huge amounts of compensation. Therefore the remedy for the tort of oil pollution is not confined to compensation between the infringing party and the aggrieved party. In most countries., the law commonly makes adjustments to elements of compensatory liability for oil pollution damage and implement principles of liability without fault and reversion of burden of proof. At the same time, most countries build up protection systems for damage compensation, with individual or comprehensive systems of compulsory insurance, financial security, compensation or indemnity funds, social security systems, and so forth, in order to ensure that the aggrieved party can actually obtain compensation despite problems of solvency, bankruptcy, closedown of the infringing party, or long-lasting litigation. Direct action also legally reflects the change of the value orientations from “merely paying attention to the assured’s interests to gradually and compulsorily protecting the aggrieved third party and the social public”. However, since direct action breaks the traditional principles of the “doctrine of remedy for insurance damage” and the “privity of contract”, legislators of most countries set up strict conditions for the application of direct action against oil pollution.

The 1992 CLC brings the system of direct action into compensatory litigation for oil pollution damage and, like other laws, also sets strict conditions for the application of direct action. More precisely, direct action under the 1992 CLC is completely built upon the foundation of compulsory insurance/financial security. Only under the the condition of compulsory insurance/financial security can direct action ensure a timely compensation to the aggrieved party of oil pollution and avoid infliction of strong impacts on the insurance industry and P&I clubs. The 2001 Bunker Convention adopts the same system of direct action as the 1992 CLC but also provides that the registered owner of a ship of over 1,000 gross tonnage and registered in a Contracting State should maintain insurance or other financial security.  National laws such as the US Oil Pollution Act of 1990 allow direct action, but this Act requires the vessels to maintain insurance, surety bond or guarantee, which are equivalent to the sum calculated in accordance with the tonnage of vessels as stipulated by this Act.

Article 97 of the Special Maritime Procedure Law stipulates as procedural law that an aggrieved party may directly claim against the insurer who is answerable for liabilities of the owner of the ship causing oil pollution damage, or against the person who provides financial security therefor. Does this make compulsory insurance/financial security a prerequisite for direct action under Chinese law? According to the explanation of the draftsmen of the Special Maritime Procedure Law, the factual basis of Article 97 is “compulsory insurance” provided in the 1992 CLC to which China has acceded, and is the implementation of the provision that “the State shall perfect and put into practice the civil liability system of compensation for vessel-induced oil pollution, and shall establish a fund system for vessel-induced oil pollution insurance and oil pollution compensation” provided in the first clause of Article 66 of the Marine Environment Protection Law revised in 1999.  Therefore, judging from the real intention of the legislators, the basis of direct action against oil pollution is also “compulsory insurance” under Chinese law. In respect of oil pollution cases caused by CLC vessels, there would be no problem for the commencement of direct action against the P&I club. But for oil pollution cases caused by non-CLC vessels, although the second clause of Article 66 of the Marine Environment Protection Law of P.R.C. provides that, “specific measures for the implementation of vessel-induced oil pollution insurance and an oil pollution compensation fund system shall be formulated by the State Council”, currently the State Council has not formulated any specific measures in this regard.  Therefore, in such cases, there it is unclear if aggrieved parties of oil pollution may bring a direct action against P&I clubs or not.

II. 　“Pay first” clause in P&I insurance contract

Many countries where direct action is permitted differentiate between the indemnity insurance policy and the liability insurance policy, usually excluding direct action against the indemnity insurer. The UK and some US states for example do not allow direct action against P&I Club. The reason rests with the fact that in indemnity insurance, the insurer usually pays only after the assured has already indemnified the aggrieved parties. Typical rules of a P&I club often include the provisions that unless the Directors otherwise determine at their discretion, it shall be a condition precedent of an Owner’s right to recover from the funds of the Club in respect of any liabilities, costs or expenses that it shall first have paid. This is the so-called “pay to be paid” or “pay first” clause.

P&I insurance provided by a P&I club is traditionally an indemnity insurance. In the meantime, certain differences also exist between P&I insurance and commercial liability insurance, which are embodied in the characteristic of “mutual” of P&I insurance where risk and financial resources are shared. A P&I club indemnifies its members only for a sum they should pay and have actually paid off. The “pay first” clause is included into P&I club rules to ensure the financial strength and stability of each member. However, with the development of the third party’s right to the insurer, the boundary between liability insurance and indemnity insurance is becoming increasingly obscured.

In US, some states have enacted a law of direct action of the third party allowing aggrieved parties to bring a direct action against the insurer; these states deny the legal validity of the “no litigation” clause in insurance contracts because it violates public policies. Other states also prohibit the issuance of insurance policies in which there is no express provision that the third party is entitled to bring a direct action against the insurer when the assured is insolvent, and they even consider that the insurer cannot invoke certain defenses specifically against the assured. Under these circumstances, an indemnity insurance policy is effectively changed into a liability insurance policy.

In UK, according to the Third Party Rights Against Insurers Act 1930, a third party may claim against the insurer where two conditions are met, namely (1) the assured has become bankrupt or wound up; or (2) the assured’s liabilities to third parties have been determined. Obviously the “pay first” clause contradicts the above Act. Under such circumstances, will the “pay first” clause be declared invalid similar to the “no litigation” clause of US, affecting the indemnity nature of P&I insurance? This problem was solved by the case of The Fanti and the Padre Island.  The House of Lords followed an ordinary and natural construction of the P&I club’s rules to hold that cargo-owners shall not subrogate rights superior to those of shipowners. Furthermore, the transferable rights of the Third Party Rights Against Insurers Act 1930 only refer to the rights shipowners have already obtained. When shipowners do not satisfy the condition precedent of “pay first”, they do not have the right to claim against the club, and so cargo-owners in their turn do not have that right. Under the equitability doctrine, an order may be issued to the indemnifier to directly pay the third party or under certain circumstances to pay the indemnified party so as to specifically perform an indemnity contract. However, this doctrine will not apply if the contract includes express terms to the contrary. Moreover, the law does not invalidate a “pay first” clause, as it takes effect not only in special circumstances (i.e. the assured is insolvent) but always. The House of Lords also denied the idea of the conditional transfer of rights and interests, holding that only rights having already been obtained by the assured can be transferred. Thus, the validity of the “pay first” clause was affirmed, although Lord Goff did mention that the “pay first” clause should be invalid in the cases of loss of life or personal injury.

In China, the “pay first” clause should be regarded as a contractual clause agreed between the P&I club and its members. According to Article 52 of the Contract Law of P.R.C., a contract is invalid under any of the following circumstances: (1) either party enters into the contract by means of fraud or coercion and impairs the State’s interests; (2) there is malicious conspiracy causing damage to the interests of the State, of the collective or of a third party; (3) there is an attempt to conceal illegal goals under the disguise of legitimate forms; (4) harm is done to social and public interests; or (5) mandatory provisions of laws and administrative regulations are violated. Meanwhile Article 56 provides that, “if a part of a contract becomes invalid without affecting the validity of the other parts, the other parts remain valid”. In the light of the aforesaid legal provisions, the validity of “pay first” clause may be weakened by the circumstances under (4) and (5).

China is a member state of the 1992 CLC which provides that a P&I club is entitled to base its defense on those rights that the assured may invoke in its defense, (except insolvency or closing down), or on the argument that the oil pollution damage is intentionally caused by the assured. Also, the P&I club is unconditionally entitled to a limitation of liability. The Convention however has not provided that a P&I clubs may defend by reliance on other matters. Therefore, with regards to cases of oil pollution caused by vessels of member-states to the CLC, a P&I club should not be able to rely on the “pay first” clause to defense a third party.

With regards to cases of oil pollution caused by non-CLC vessels, however, there are no mandatory regulations relating to the “pay first” clause in Chinese domestic laws and administrative regulations. Can the aggrieved parties weaken the validity of such a clause by alleging that it poses harm to social and public interests? In China, it is totally up to judges’ right of free discretion to decide what are the social and public interests. In addition, oil pollution damage may have an impact on the interests of public environment, and “the courts usually consider that damage compensation would cause no harm to anybody and so are inclined to compensation after damage occurs regardless of the common rules of tort law” ; the traditional view of “who causes damage shall be responsible for it” is replaced by the contemporary view that “damages are borne by the society”.  In this respect, in cases of oil pollution caused by non-CLC vessels, the validity of the “pay first” clause is likely to be weakened.

III. 　Other defenses of the P&I club

As discussed above, under the 1969 CLC, the insurer’s defenses against oil pollution damage include those rights that the assured may invoke in its defense, (except insolvency or closing down), or the intentional cause of the damages by the assured, and the insurer also is entitled to the limitation of liability unconditionally. But the direct action stipulated in this Convention is set upon two fundamentals, namely compulsory insurance or financial security and the right of the liability insurer to unconditionally enjoy a limitation of liability.

Under the mechanism of compulsory liability insurance, direct action of the third party is a right of petition without attachment of any defense. Such right is directly endowed by law. The exercise of the right of petition by a third party will not be affected by the insurer’s right of defense against the assured in an insurance contract. This is because under the system of compulsory insurance the legislature intends to protect the rights and interests of aggrieved parties. If the insurer frequently rejects a third party’s claim for compensation on the excuse that the assured has failed to perform its contractual obligations, the purpose of compulsory insurance cannot be realized.

From another perspective, the mechanism of compulsory liability insurance increases the risks covered by the liability insurer of oil pollution and deprives the liability insurer of defending rights he originally had in accordance with the insurance contract. This is disadvantageous to the accurate assessment of risks by the liability insurer when he is considering insurance coverage. If the liability insurer has no way to assess future risks, he will be unwilling to underwrite liability insurance of oil pollution. Thus, although the mechanism of compulsory liability insurance can protect the interests of aggrieved parties of oil pollution, objectively it may be difficult to market the mechanism.

In order to settle this problem, the 1969 CLC provides that the liability insurer is unconditionally entitled to the limitation of liability. This provision deprives the liability insurer of the right to defend by reliance on the defenses enjoyed by the assured, making the insurance actuary a possibility. Thus the liability insurer can calculate the maximum liabilities for risks it has covered. Using this, the liability insurer to assess risks and fix premiums and the mechanism of compulsory insurance can be implemented.

Unlike the 1969 CLC, Chinese domestic law does not contain provisions on the defenses that can be invoked by liability insurers of oil pollution. As stated above, currently the State Council has not formulated any specific measures for the implementation of vessel-induced oil pollution insurance and an oil pollution compensation fund system. A system of compulsory liability insurance for oil pollution has not been constructed. On the other hand, Article 206 of the Maritime Code provides that, “where the assured may limit his liability in accordance with the provisions of this Chapter, the insurer liable for the maritime claims shall be entitled to the limitation of liability under this Chapter to the same extent as the assured”. This indicates that it is a condition precedent for the liability insurer of oil pollution to enjoy limitation of liability under Chinese law that “the assured is entitled to limitation of liability”. If the assured loses the right of limitation of liability due to its own fault, the liability insurer of oil pollution also has to bear the consequences of the assured’s conducts, namely it loses the right of liability limitation. Thus, the two fundamentals (compulsory insurance, and the liability insurer’s unconditional entitlement to liability limitation), on which the liability insurer of oil pollution is not entitled to resist aggrieved parties of oil pollution by reliance to defences against the assured under the 1969 CLC, do not exist under Chinese law.

Therefore, we consider that when aggrieved parties of oil pollution bring a direct action against a P&I club as per Article 97 of the Special Maritime Procedure Law, the ground of substantive law in respect of the third party’s right of petition for direct action against the P&I club should be firstly ascertained. If the third party’s right of petition for direct action originates from 1992 CLC, i.e. compulsory liability insurance, the third party’s right of petition for direct action is a right of petition without attachment of any defense. The P&I club may not resist the third party by relying on defense against the assured under the P&I insurance contract. On the other hand, in respect of cases of oil pollution caused by non-CLC vessels, as the liability insurance of oil pollution in such cases is not compulsory liability insurance, and at the same time the liability insurer is not unconditionally entitled to limitation of liability, the third party’s right of petition for direct action should be a right of petition with attachment of defense, and the P&I club would be entitled to resist the third party by reliance on the defenses against the assured under the P&I insurance contract. This approach both embodies the differences between compulsory liability insurance and non-compulsory liability insurance, and also pays respect to balancing the interests of the social public and the interests of the P&I club (as well as other commercial insurers).

Conclusion

In China, although P&I clubs are likely not legally an insurer, especially China P&I Club, in shipping and judicial practice they have already been regarded as the liability insurer of oil pollution. It has been suggested that the Insurance Law of P.R.C. should revise its definition of “insurance company” and leave proper room for the existence of P&I clubs and possibility of compulsory insurance of oil pollution. In cases of oil pollution induced by CLC vessels, while the validity of the “pay first” clause is weakened, the defenses of P&I clubs are statutory and so they may not be entitled to resist a third party by reliance defenses against the assured under the P&I insurance contract. In cases of oil pollution induced by non-CLC vessels, however, the validity of the “pay first” clause is still pending test of practice. It is likely, however, that P&I clubs would be entitled to resist the third party by reference to the defenses against the assured under the P&I insurance contract.